What is a PPP?

There are many different
definitions of public private partnerships and such arrangements can
take on many different forms.  In general terms though a public private
partnership or PPP can be defined for the purposes of this paper as:
“a
contractual agreement formed between public and private sector partners
that meets clearly defined public needs through appropriate allocation
of resources, risks and rewards and which may also involve the use of
private sector capital to wholly or partly fund an asset that would
otherwise have been purchased or constructed directly by a government
agency”.

It is important for this discussion to distinguish
between the wider concepts of ‘partnering’ and ‘procurement’ and the
more specific concept of the PPP.  Partnering is not new in New Zealand
and the private sector has been contracting to provide assets and
services to all levels of government for many years.  Indeed, in recent
times, the private sector has played an increasing role in the
provision of public infrastructure and public services.  However, the
key distinction between a government agency contracting with the
private sector to construct or purchase an asset or obtain a service
and a PPP is that in the former examples the private sector takes no
‘ownership’ risk in connection with the asset or service – it merely
performs the functions it is contracted to provide.  In a PPP, risks of
‘ownership’ and operations of public infrastructure are transferred
wholly or partly to the private sector party.

PPPs themselves
are not new concepts either.  They have existed in various forms
internationally for many years.  One study  estimates that in excess of
2000 public infrastructure projects have been proposed and/or developed
internationally using PPP with a total value in excess of US$850
billion in the period 1985 – 2004.  The total will certainly be higher
today.  PPPs have been used to develop both economic infrastructure and
social infrastructure including roading, rail, airports, seaports,
water and waste water, hospitals, prisons, schools, housing and other
infrastructure facilities.  There have even been several projects in
New Zealand which fall within the definition of PPPs such as the
Wellington and Hutt Valley water and waste water projects, Vector Arena
in Auckland, Papakura District Council’s franchising of its water
facilities and several healthcare facilities.  There have been other
PPP projects planned which have not yet come to fruition, particularly
in the roading and land transport arena such as the Penlink PPP Project.

There are a number of different ways in which a PPP can be structured and most have associated acronyms.  Some of these are:
•
Build Operate Transfer / Build Own Operate Transfer / Build Transfer
Operate (BOT / BOOT / BTO) – These are variations on a project delivery
method typically involving the design, construction, finance and
operation of a facility whereby the contractor acquires ownership of
the facility until the end of the contract term at which time ownership
of the facility is returned to the original public sector sponsor;
•
Build Own Operate (BOO) - This is a project delivery method similar to
BOT whereby the contractor both owns and operates the facility with no
transfer at the end of the term;
• Concession – This is an
arrangement which grants the contractor full responsibility to finance,
build, operate and / or maintain the facility as a franchisee for a
specified period of time.  
• Design Build Operate Maintain (DBOM) –
The contractor is responsible for the design, construction, operation
and maintenance of the facility for a specified period of time and
payment is predicated on meeting certain prescribed performance
standards relating to physical condition or capacity of the asset.  
•
Design Build Finance Operate (DBFO) – This is an extension of the DBOM
project delivery method in which the contractor is also responsible for
financing the project;
• Management Contracts – This is a
contractual arrangement under which the contractor manages the
provision of a specified function or asset at certain performance
standards over a set period of time.  These contracts typically do not
involve the use of private financing but do represent additional
responsibilities and risk for the private sector partner beyond a
standard operating contract.

Overseas Experience of PPPs in Land Transport
PPPs
in various forms have been used for rail and road development for
centuries.  In modern times Spain and France pioneered the use of PPPs
for the development of motorways in Europe.  Spain began inviting
concessionaires to build its motorway network in the 1960s while
private autoroute concessions in France date from the 1970s.  These
earliest concessions tapped into private funding sources freeing up
public monies to be used on other projects.  The private concession
companies were generally consortia comprised of construction companies
and banks.  The original economic and political drivers for introducing
these concepts for the development of roading infrastructure were
principally a need to accelerate infrastructure development to cope
with growing economies and the need to find alternative funding for
capital intensive infrastructure projects.

Unfortunately the
early experiences in Spain and France ran in to difficulty in the 1970s
with the oil shocks.  With their heavy reliance on petroleum based
inputs, construction costs skyrocketed while traffic flows declined. 
The economic pressures of the time also resulted in governments
limiting the rate of toll increases, contrary to the terms of the
relevant concession agreements, in a bid to assist with inflation
control.  This of course was bad news for the concessionaires operating
the networks who relied on the tolling to meet their debt servicing
costs.  Over the following years, the governments of both Spain and
France effectively nationalised many of the private concessionaries
merging them into existing public companies.
 
The UK joined the
PPP revolution in the 1980s with the first major project being the
Dartford Crossing, the concession for which was awarded in 1986. 
Interestingly, with a few exceptions, the UK did not pursue a direct
toll model for roading projects but preferred to adopt the shadow toll
approach.  

Under a shadow toll arrangement public sector
sponsors make payments to concessionaires based on the number and type
of vehicles using the facilities.  The amount of shadow toll payments
can be adjusted by reference to target service levels including
availability and safety conditions.  Motorists themselves pay no tolls
directly with the shadow toll payments generally being funded from fuel
and excise tax or the general funds of the sponsor.  For private road
developers the primary benefit of the shadow toll approach is to
minimise traffic risk.  Given that motorists themselves do not have to
pay tolls directly, their choice of route is made solely based on time,
distance and convenience and is therefore much easier to predict. 
Shadow tolls also reduce cost by removing the need for expensive direct
tolling systems to be installed and operated.

At the same time
as the UK experiments with its PFI initiative were unfolding in the
1990s, there was also a resurgence of direct toll motorway development
in Europe.  The sweeping structural changes which occurred across
Europe during the 1990s supported the use of PPPs as an important tool
to meet the European Union’s infrastructure needs.  These included the
goal of creating a series of trans-European networks, both rail and
road, that would create new and improved transport connections within
the European Union.  Coupled with this bold desire to expand the
trans-European networks, European policy also established fiscal
standards and budgetary discipline for member nations.  This, at the
time, put pressure on governments to seek alternatives to government
debt financing for large capital intensive infrastructure projects and
as a result many turned to PPPs.

As you drive through France,
Italy and Spain today, tolled motorways are a fact of life.  They
provide an excellent service with comprehensive networks linking all
major cities.  This backbone for the movement of people and goods
throughout Western Europe delivers real economic benefits and those
projects operated by PPPs have largely been successful.  One of the
most iconic recent PPPs is the Millau bridge project across the Tarn
river valley in southern France.  This magnificent example of modern
engineering and design was constructed by the Eiffage consortium under
a long term concession arrangement.  The toll bridge has cut up to an
hour off the standard alternative journey time.  It cost approximately
€400M to build and has been an enormous success, carrying over 4
million vehicles in its first year of operation and also becoming a
tourist destination in its own right.

The European examples,
whilst interesting are difficult to translate to New Zealand
circumstances because of legal, political, economic and structural
differences in the economies.  For New Zealand purposes, however, there
are good examples of PPP frameworks closer to home which are more
easily adaptable to our circumstances.  Australia, led by the State of
Victoria, has developed an extensive PPP framework and has a track
record of successful PPP projects including a number of land transport
projects.  The first major land transport PPP project in Australia was
the Sydney Harbour tunnel which was completed in 1992.  Since then PPPs
have been used to deliver infrastructure projects and services over a
range of sectors including land transport (road and rail),  

The
early PPPs in Australia were driven initially by a need for the States
to find alternative funding sources and to achieve off balance sheet
financing for the significant cost of infrastructure developments.  As
economic conditions during the 1990’s changed and the financing
pressures were relieved, the Australian State governments continued to
develop the PPP concepts based on a policy that increased private
sector involvement in infrastructure services could drive growth and
efficiency and achieve better outcomes over what the governments
themselves could achieve.  The Australian PPPs of the 1990’s were
generally characterised by:
• a high level of risk transfer to the private sector;
• the private sector being responsible for full service provision;
• the private sector entity not being paid until the commencement of services; and
• the government not guaranteeing returns as it did in the late 1980s and early 1990’s.

Examples
of PPPs of that period in Australia include the Melbourne City Link
project, various water and waste water treatment plants as well as
several hospitals.  While the economic and financial outcomes of PPPs
from that period are considered largely positive, the quest for maximum
risk transfer and private sector efficiencies led to some contracts
being unsustainable with the relevant government sponsors having to
restructure the arrangements or, in some cases, step in and assume
control of the projects.

From 2000 to today, the Victorian State
government has continued the development of PPPs with the focus being
on the delivery of value for money, public interest and optimal risk
transfer.  This current approach is outlined in the “Partnerships
Victoria” policy.   The current policy and guidance materials have
incorporated the lessons of the past and are now very comprehensive. 
There is a clear quest to achieve value for money with a focus on
“whole of life” costing and optimal, as opposed to maximum, risk
transfer to the private sector. The “value for money” assessment is
made using sophisticated public sector comparators.  The public
interest is protected through a formal public interest test for each
PPP project and direct responsibility for delivery of core public
services is clearly identified as being retained by the government.  If
a project does not pass the value for money and public interest tests
then it is not developed as a PPP and the government agencies are
directed to traditional procurement methods.  The Partnerships Victoria
model has been adopted and further developed by other states in
Australia and the Australian Federal Government.

The New Zealand Framework – Land Transport Management Act 2003
The
current framework for land transport funding, including the
establishment of PPPs in the land transport sector in New Zealand, is
set out in the Land Transport Management Act 2003 (the “Act”).  The Act
provides for PPPs by empowering public road controlling authorities to
enter into concession agreements between a third party and a public
road controlling authority relating to the construction or operation of
a roading activity.  It also provides a separate mechanism for approval
of road tolling schemes.  A PPP will generally involve tolling but road
controlling authorities can use tolls without having to enter into a
PPP, hence the different regimes in the Act.  Concession agreements
under the Act can generally contain whatever provisions are agreed
between the public road controlling authority and the concessionaire. 
However, before entering into a concession agreement the public road
controlling authority must obtain the responsible Minister’s prior
written approval and satisfy the Minister that any conditions imposed
by the Minister, have been met.

The term of the concession
agreement must not exceed 35 years from the date on which the road is
open to the public.  This term may be extended once only for a further
period of up to 10 years if there are exceptional circumstances
justifying the extension.  Application for an extension can only be
made once two-thirds of the original term has elapsed.

A
concession agreement under the Act must not include any provision that
provides a disincentive for a person to pursue other sustainable
transport options.  For instance, the concession agreement could not
contain a provision preventing the relevant authority from building any
competing infrastructure, imposing any demand management regime on
connecting infrastructure or providing any alternative public transport
which would otherwise affect demand for the new road.  This requirement
will be a key negotiating point in any concession agreement under the
Act, as any concessionaire will naturally seek assurances from the
concession granting authority that, as far as possible, the assumptions
upon which the initial analysis of the project has been undertaken
prior to entering in to the concession agreement (a key one being
traffic forecasts) will remain fixed for as long as possible.  An
interesting example of this in the Auckland context would be if a
concessionaire wins a concession agreement to construct a harbour
crossing providing access to the central business district which is to
be tolled at an agreed level and the concessionaire satisfies itself as
to the viability of the project based on certain traffic forecasts and
a certain level of tolling.  If the government or the relevant
territorial authority subsequently introduces congestion pricing so
that motorists are charged a fee to enter the central business district
(similar to Singapore and London) , the combination of the congestion
pricing and the toll on the harbour crossing are likely to
significantly impact the traffic flow and, by implication, the income
for the concessionaire.  A provision in the concession agreement in the
form of an undertaking from the government or the relevant authority
that it will not take any steps which would have the effect of reducing
the traffic flow would not be permitted under the Act and this risk
will need to be addressed in another way.

The approval process
for concession agreements allows a public road controlling authority to
obtain an “approval in principle” to enter into a concession
agreement.  Such approval will specify conditions relating to the broad
terms of that concession agreement.  The public road controlling
authority will then be able to seek tenders from potential
concessionaires with a sufficient degree of certainty about the key
terms of the concession agreement they will be able to offer.  Once the
tenders are received and the negotiation with the preferred tender is
completed, the final sign-off from the responsible Minister can be
obtained.

Before approving a concession agreement the Minister
must be satisfied that the proposed agreement contributes to the
purposes of the Act.  The Minister must also have taken into account
how the proposed arrangement assists economic development, assists
safety and personal security, improves access and mobility, protects
and promotes public health and ensures environmental sustainability. 
The Minister must also have taken into account any relevant existing
transport strategies (national or regional), the availability of
alternative transport options, whether the activity is consistent with
current priorities for land transport expenditure and the outcome of
consultation undertaken prior to the application being made.

The
consultation requirements that must be met before an application is
made for approval of a concession agreement are reasonably extensive
but credit is given for consultation undertaken under other provisions
of the Act or under other legislation.

The key requirement of
concession agreements is that the land and road comprised in the
agreement will be publically owned throughout the term of the
agreement.  Leases of the relevant land for not longer than the term of
the concession agreement are permitted.  Interestingly, other forms of
property interests, including licences, are not permitted.  The reason
for this appears to be to ensure that the concession agreement regime
does not inadvertently catch day to day contracting by public road
controlling authorities, i.e. it is only arrangements that grant a
lease to the concessionaire that are deemed to be concession agreements.

The
concession agreement will establish a regime whereby either payments
are made to the concessionaire by the relevant authority under a shadow
tolling or some other mechanism or the concessionaire will be granted
the authority to collect direct tolls from users.  If tolls are to be
levied, the Act provides a separate regime which requires separate
Ministerial consent for the implementation of the tolling scheme. 
Similar to the concession agreements regime, extensive consultation
needs to have been undertaken by the relevant authority prior to
establishment of a road tolling scheme.  Points to note in relation to
the establishment of tolling are the requirement that tolls be levied
principally on new infrastructure.  Tolls can be levied on existing
roads only if the existing road or part of it is located near and is
physically or operationally integral to a new road in respect of which
tolling revenue will be applied.  The other point is that prior to
approving a tolling scheme, the responsible Minister must be satisfied
that there is an available alternative to road users which is untolled.
 
The
Order in Council which is finally made upon the approval of a tolling
scheme will describe the relevant road to which toll revenue may be
applied and that part of the road or roads which are to be tolled
together with any other conditions that must be met to the satisfaction
of the Minister for the scheme to be approved.  The Order may also set
the level of tolls or empower the relevant public road controlling
authority or toll operators to set tolls according to criteria to be
specified.  Differential levels of tolls on any basis approved are
permitted.
 
The Act is currently subject to amendment by the
Land Transport and Management Amendment Bill 2007 (the “Bill”).  This
Bill makes a number of changes to the underlying legislation, the
principle ones being:
• to reserve fuel excise duty for land transport purposes only and changing the way that fuel excise duty is set;
•
providing a regime for the establishment of regional fuel taxes, the
intention of which is to allow regions to collect revenue to fund more
projects;
• changing the mechanisms for development of government
policy statements (setting out the government’s planned investment and
funding priorities) to provide more strategic guidance to the transport
sector and introducing regional land transport programmes to
regionalise land transport planning documents, reduce consultation and
encourage integrated land transport planning;
• increasing the term
of regional transport strategies and the national land transport
strategy to 30 years to recognise the long term nature of transport
investment; and
• merging Land Transport New Zealand, the office of the Director of Land Transport and Transit New Zealand into a single entity.

All
of these changes were signalled last year and the legislation is
largely mechanical in terms of its implementation.  From a PPP
perspective an important change is the introduction of the mechanism
for levying regional fuel tax by a controlling authority which could be
used to fund the payment of shadow tolling or to make payments to a
concessionaire under a PPP arrangement.  Perhaps more importantly
though are the  changes to the planning regime which should allow for
better integration of land transport planning both regionally and
nationally.
 
Whilst the framework for the establishment of PPPs
for development of land transport projects has existed since 2003, none
have yet been implemented.  Nor has New Zealand had the need or desire
to actively pursue the development of a more general PPP framework that
applies beyond land transport in the same way in which Australia and
the UK have done.

Accordingly, the way ahead for PPPs in New
Zealand is still somewhat unclear but, with the government’s
announcement on 7 February 2008 of the establishment of a joint public
and private sector steering group to investigate whether a PPP could be
the preferred structure for developing the Waterview connection tunnel
project in Auckland, it appears that there is some political willpower
to at least progress the discussion on whether PPP’s could be used in
appropriate circumstances.

Advantages of PPPs
The
advantages and disadvantages of PPPs have been widely debated here in
New Zealand and overseas.  In New Zealand the debate has been largely
theoretical due to the fact that there is little real life experience
of PPPs in this country.  A paper published by the New Zealand Treasury
in March 2006 entitled “Financing Infrastructure Projects: Public
Private Partnerships”  came to the conclusion that there was little
that a PPP could offer in the New Zealand context.  This paper appears
to have influenced government thinking during 2006 and 2007 but it is
encouraging to see that the possibility of a PPP for a major land
transport project is now being actively investigated.

Some of the perceived benefits of adopting a PPP project delivery structure are as follows:
•
For the public sector and the public in general, a PPP’s primary
benefit is as a tool to deliver more and better infrastructure and
better services for a cheaper cost than what could otherwise be
achieved through traditional procurement methods.  UK research has
demonstrated that a greater proportion of PPP projects were delivered
on time and on budget than traditional procurement projects.

•
Since the private sector assumes responsibility not only for the
construction but also for the operation of the project, private sector
bidders are forced to take a “whole of life” approach to costing. 
Integrating the different functions of design, construction and
operation releases the synergies between them and discourages low capex
/ high opex solutions which have sometimes been the outcome of
government tendering processes which focus solely on lowest delivery
cost.  

• PPP contracts concentrate on the “what” not the
“how”.  This is an important distinction and requires a clear
understanding by the government sponsors who wish to explore PPPs as an
alternative contracting option of how a PPP will deliver the best
outcomes.  The UK and Australian experience has been that in the past,
the public sector specified what it required to the last detail leaving
private sector contractors with little scope to bring innovation in
design and specification or to compete other than on the basis of the
lowest cost in the short term.  A switch to output specifications
allows innovation in design, avoids gold plating and has been shown to
deliver service benefits over the life of the contract.  

• The
public sector receives guaranteed services of a specified quality
because it is usually on that basis that the private sector partner
gets remunerated.  The private sector partner is motivated to perform,
failing which its income would be jeopardised.  Unfortunate though it
may be, commercial or market economic incentives are often more
effective at providing motivations to achieve the specified outcomes
than traditional public sector management incentives. This is not
necessarily the case in New Zealand as we have, since the introduction
of SOEs, developed a very efficient corporatised model for operating
publicly owned assets.

• Risks can be allocated and managed
more efficiently by allocating to the private sector responsibility for
managing and delivering service and to the public sector the
responsibility for policy and legislative frameworks.  Risk transfer is
a major benefit in PPPs and, as discussed below, one of the key
determinants of whether a PPP should be adopted.

• Access to
capital by transferring the responsibility for funding the development
of infrastructure to the private sector under a PPP.  This can be a
particular advantage where a government sponsor has funding constraints
but it is usually not the only justification for adopting a PPP model
in industrialised countries.  Many commentators criticise the funding
motivation for undertaking PPPs.  Because governments are usually able
to borrow money more cheaply than the private sector, it is argued that
projects should be financed by public debt rather than private finance.
 

This argument however is somewhat simplistic as the true costs
of a project to government should be viewed as not just the cost of
raising the debt but also the costs of assuming the risks of the
project.  This cost of the risk of the project has often been
undervalued in traditional government contracting.  It is also worth
noting commentary from recent Australian reports  which observe that
the difference between private sector and public sector borrowings is
that the private sector capital markets explicitly price in the risks
of a project.  This is not the case for the public sector borrowing
which does not distinguish between general government debt and debt for
specific projects.  The result is that if one focuses solely on the
government’s cost of borrowing, it ignores the implicit subsidy by
taxpayers of project risks which aren’t reflected in the cost of
finance.

• The achievement of off-balance sheet financing may be
seen as an advantage of PPPs.  Given the new IFRS accounting rules
which apply in New Zealand and internationally and the New Zealand
government’s own accounting practices, the ability to achieve
off-balance sheet financing for a major infrastructure project under a
PPP structure is likely to be limited and this is not of itself
generally a motivation for choosing PPPs over other potential
structures but it may be a beneficial outcome.

• The creation of
opportunities for technology transfer from the private sector to the
public sector.  This is less likely to be a major factor in a roading
project where the technology is largely well established and, in New
Zealand’s case, Transit is already a market leader in the design and
construction of roading infrastructure.  Where a private sector entity
may be able to add benefit is in the associated services such as
tolling technology or, if the project requires innovative engineering
solutions.  Once again though, this is only one potential advantage of
PPP and technology transfer can also occur under other structures such
as project alliances.

Disadvantages of PPPs
Some of the regularly discussed disadvantages and criticisms of PPPs are as follows:
•
PPPs are often criticised as having disproportionately high costs
associated with their implementation, both for the sponsoring
government entity and for the private sector entities participating in
the tender process.  This high cost discourages private sector entities
from becoming involved in a PPP tender process which in turn reduces
the competitive tension in the process and potentially affects the
value for money which might be achieved by adopting a PPP structure. 
Various statistics provided by commentators from a number of
jurisdictions give a wide range of bid costs depending on the nature of
the project with some projects having bid costs of over $10 million. 
There are a number of ways in which this often valid criticism can be
addressed.  In Australia and the UK the government entities responsible
for administration of PPPs have attempted to address the issue by:
-
development of very clear standardised criteria for PPP projects which
apply to all government sectors seeking to utilise the structure;
- development of standard form documentation;
- improving the quality and clarity of tender documents, particularly with respect to the output specifications required;
- not requiring the tenderers to have committed sources of finance to be locked in at the expression of interest stage; and
- using a more consistent and transparent risk allocation process aligned with published guidance material.  

New
Zealand clearly does not have the luxury of having a well developed
framework for PPPs of the standard of the Partnerships Victoria model. 
In any PPP project entered into in New Zealand it will however be very
important to have very clear criteria for the projects which are under
consideration and a transparent tender process.  This process should
include early and full disclosure of the assumptions and calculations
which are used in the public sector comparator developed by the
government sponsor to assess any bids against a standard government
procurement model.  

Also, government sponsors will need to have
or develop the skills to actively manage the PPP process.  This will
involve a commitment to cost and time by the sponsor.  PPPs are not a
solution that allows the sponsor to award the contract and walk away
until the end of the concession.  The arrangement is after all a
partnership which requires active input over the life of the project
from both parties.

• In a small market like New Zealand there is
no benefit in adopting a PPP structure as there are not sufficient
numbers of experienced private contractors to create the competitive
tension required to achieve the best value for money.  It is true that
New Zealand is not a large market.  However, there are a number of
world class contracting entities operating in New Zealand who have the
capability not only to construct but also manage and finance a major
infrastructure project.  The expectation is that, given the proximity
and similarity of the legal and political systems, any PPP project in
New Zealand would be likely to attract interest from entities who
currently undertake similar projects in Australia and a consortium
between one of the local construction companies and a foreign
infrastructure investor and operator is a likely and sensible outcome.

•
PPP arrangements are inflexible and result in the government
subsidising the private sector.  An obvious concern given that PPP
agreements are typically long-term arrangements is that both the public
sector party and the private sector party will have to ensure that the
agreement has clear provisions to deal with a change in circumstances. 
An example of the type of situation that will need to be considered is
where the pricing of the service offered under the PPP or the tolls
charged will escalate unreasonably or fail to keep step with the market
pricing if the market is expected to fall.  The risk from the
government sector’s perspective is that this could lead to the private
sector entity making “super profits” which would be politically
unacceptable.  Equally, from the private sector’s perspective, if the
PPP arrangement has transferred risks of operation to the private
sector party such as, in the case of a transport project, traffic
demand risk, there is an equal argument to justify the private sector
party earning and keeping any upside given that it is also taking the
downside risk.  These criticisms often overlook the obvious
‘counter-factual’ which is that if the project had been developed using
traditional government procurement methods the government would be
assuming the same risks as the private sector party and/or, on the
flipside, enjoying the equivalent benefit.  The “super profits”
question has been addressed in the UK and Australia by including in the
contract documentation provisions to ensure that any such gains which
arise as a result of a change in the underlying assumptions upon which
the project was originally priced are shared between the public and the
private sectors.

These benefit sharing provisions generally also
apply to the situation where the private sector refinances its initial
investment at better rates, improving on the assumptions in the
original pricing model.  The key of any mechanism that seeks to address
changed circumstances is to ensure that the fundamental risk
allocations and economics of the project are maintained.  

•
PPPs carry an implicit government guarantee and therefore should be
priced as government risk.  It is natural for public sector sponsors to
worry about service delivery failure of its counterparts.  It is true
that in Australia and elsewhere there have been a number of PPP
projects which have failed and which have required the government
sponsor to restructure the project or to step in and assume the
ownership and operation of the project.  Interestingly, in many
projects in the UK and Australia which have suffered difficulties, the
difficulties often arose due to deficiencies in the establishment of
the initial criteria and scope of the project rather than failure by
the contractor to perform its obligations.

For example, the
Spencer Street Station redevelopment in Melbourne imposed unrealistic
working requirements on the contractor which led to excessive delays. 
One could argue that the contractor should not have bid so aggressively
when the working constraints were disclosed as a condition of the
tender. However, the government sponsor also needs to be realistic in
its risk allocation and in the setting of the performance standards.

Failure
of a private sector counterparty is also a risk for a government sector
entity entering into a PPP contract.  Some of these risks can be
mitigated by parent guarantees, bonds and other common contractual
provisions.  Equally, the private sector contracting entity should not
assume that because they are contracting with a government entity and
providing a public service, that they will always be kept whole if any
of the assumptions on which they have based their involvement in the
project change over time and price the risks they are assuming
accordingly.

• Some critics of PPPs claim that they are
equivalent to privatisation.  This appears to be a philosophical
objection about the line between what is privately provided and what
the state should provide.  There is no right or wrong answer to this
critisicm but it is worth noting that the private sector contracts
extensively with the government sector for provision of what are
effectively public services already.  The only difference with PPPs is
the length of the contract and the extent of the responsibilities which
are passed to the private sector.  In all PPPs, the government entity
will continue to own and have ultimate control over the asset and the
provision of the services.  This is particularly so in the New Zealand
land transport context given the framework outlined in the Land
Transport Management Act where the government continues to own the land
and will have ultimate control as the contracting party under the
concession agreement to terminate the concession in the event that the
private sector entity fails to perform its obligations.

Practical issues
It
will be important in any PPP project to very clear about the reasons
why the PPP structure is being adopted for that particular project. 
PPPs are not right for all projects.  The underlying criteria for the
project will need to be established based on the financial and
political consideration of the government sponsor.  In a New Zealand
context where the government is able to obtain financing at a much
cheaper rate than the private sector and, at least currently, has
budget surpluses, the justifications for adopting a PPP project will
need to be based on a clear “value for money” criteria which is an
expression of the economy, efficiency and the effectiveness of the PPP
structure over a more traditional procurement method.  In accordance
with Australian guidelines , the major factors to be considered when
assessing value for money in PPP programmes are, in addition to basic
cost considerations:
• risk transfer – relieving the government entity of the substantial, but often under-valued, cost of asset-based risks;
•
whole of life costing – integrating upfront design and construction
costs with ongoing service delivery and operation, maintenance and
refurbishment costs;
• innovation – providing wider opportunity and incentive for innovative service delivery solutions;
•
asset utilisation – providing greater opportunities to generate revenue
from the use of the asset by third parties (which may reduce the cost
that government would otherwise have to pay as a sole owner or user);
• output based specification – linking payment for the asset to the quality and timing of the service delivery;
•
performance measurement and incentives – securing the delivery of the
services to the required standards and encouraging continuous
improvement in a manner which is more efficient than the public sector
could achieve; and
• private sector management skills – delivering
management and operational efficiencies by using private sector
management skills.

It is suggested that these are the same consideration that should apply in New Zealand as well.

The
value for money of a project is easier to demonstrate where there has
been effective price-led competition and it is therefore in the
interests of the government sponsor to procure a high level of
competition during the bidding stage if possible.  The bids received
from potential PPP participants should ideally be prepared in a manner
which is consistent and allows for valid comparisons both between the
bids and against the public sector comparator.  For this reason it is
important to design a robust and transparent tendering process.  The
design of the tender process also needs to be carefully balanced to
ensure that the government sponsor does not use any bargaining power
which arises from the competitive nature of the process to transfer
risks in the project to the private sector which cannot reasonably be
managed by them or which it is not appropriate in the long-term
interests of the project to transfer.  If this does occur, either the
private sector participants will wish to charge higher risk premiums
or, if the price is driven down so low due to the competitive nature of
the bidding process, projects may ultimately fail because the risks
that do arise have been allocated to the parties where they cannot be
well managed.  

It should also be remembered that financiers of
the private sector participants will have their own view on the
appropriate risk allocations within the project and, given that
financiers will be providing a large portion of the investment in the
project, their requirements will be a major influence on the final risk
allocation in most PPP projects.  For this reason, government entities
should expect to be required to enter into tripartite arrangements with
the private sector partners’ financiers under which the financiers
obtain step in and cure rights and certain direct contractual
obligations against the government sponsor of the project.

These
agreements should be seen as beneficial to the government sponsor as
they provide good leverage to the government sponsor if the private
sector partner does suffer financial difficulty.  From the private
sector partner’s perspective, risk management is also very important. 
The concessionaire or project company will most likely be a special
purpose vehicle which will itself enter into separate contracts with
construction contractors, operators and financiers.  Through those
contracts the project company will be seeking to ‘back to back’ as much
of the project risks as possible.  This is a difficult balancing
exercise and one which requires skilled negotiation and professional
advice.

It is a well known truism in any project financing that
success or failure of the project is dependent on accurate
identification of risks and allocation of project risks to the parties
who are best able to manage the risks.  Some of the major risks in any
project which will need to be considered, whether it is a PPP or
otherwise, are:
• design, construction and commissioning risks – One
of the government sponsor’s objectives in PPP transactions should be to
take advantage of the private sector’s ability to bring design
innovations and construction expertise to the delivery of the
projects.  In almost all PPP deals the private sector party will be
required to assume the risk for the design, construction and
commissioning of the facilities.  The government sponsor will need to
have provision in the concession agreements to allow for appointment of
its own independent technical advisers to monitor delivery of the
project on behalf of the government sponsor and to carry out valuation
and certification roles both during construction and operation phases;
•
completion and delay risks – In any construction contract this is a
significant risk which is normally assumed by the contractor.  PPP
deals are no different.  The private sector entities should, subject to
a few limited exceptions, have an absolute obligation to bring the
facilities to completion by a pre-determined date.  There will be
extensive negotiation over the circumstances which entitle the private
sector entity to extensions of time and the amount of any penalties
payable for delay in achieving completion;
• ground conditions and
geotechnical risks –This is a standard risk in any major construction
project which is generally passed to the construction contractor.  For
roading projects and other civil engineering works it is obviously a
key risk and one which is likely to lead to delay if unexpected
geotechnical conditions are discovered.  Arguably neither party is in a
better position than the other to manage this risk and therefore it is
generally a point for negotiation;
• planning approvals – Generally,
the government sponsor should be responsible for obtaining the planning
and Resource Management Act consents for the project although the
project company would take responsibility for obtaining any variations
to the approvals which will be required as a result of design
modifications and, any subsequent renewals of any consents.  In the New
Zealand context, given the importance of any likely PPP project, it is
suggested that it would be appropriate for the government sponsor to
assume the risk of obtaining necessary RMA consents.  

It should
also be incumbent on the government to obtain all of the necessary land
rights by exercising its rights under the Public Works Act or
otherwise, rights which cannot be delegated to the private sector;
•
facility management and upgrade – Generally project companies will be
required to operate and maintain the facilities under a concession
agreement in accordance with best practice and the project objectives.

These
will generally oblige the concession company to meet minimum
maintenance and operating standards  but also to undertake improvements
where appropriate.  This risk of being required to make improvements is
one that should be expected to be passed to the project company in most
cases unless the improvements required are as a result of a change in
the service standards imposed by the government sponsor in which case
the project company should expect to be compensated for the costs of
any such improvements;
• refinancing risks – Any refinancing by the
project company will be subject to the approval of the government
sponsor.  In order to avoid the possibility of the project company
profiting from a refinancing, in recent transactions in Australia and
the UK the government entities sponsoring the project have required a
share of any financial benefits arising from the refinancing undertaken
by the project company.  The exception to this will be if the
refinancing has been expressly contemplated in the original financial
model for the project (in which case the benefit arising from the
refinancing has already been factored into the bid price) accepted by
the government and any refinancing gain realised should therefore
belong to the project company.  This risk also arises from the fact
that the project company is unlikely to get financing that is of the
same term as the concession agreement.  There is therefore the risk
that the project company is unable to refinance when its initial
financing expires leading to a default.  This risk should be a project
company risk not a government sponsor risk;

• changes in law –
Project companies generally take the risk of changes in law from
non-discriminatory or non-specific legislation although price change
negotiations if this risk materialises may be permitted in some cases. 
The project company would normally expect to be able to recover from
the government sponsor cost increases arising from any discriminatory
changes in law or specific changes in law affecting the project such
as, for instance, if the government places a new restriction on the
level of tolls which can be charged by the project company or the
government introduces other legislation which adversely affects the
expected traffic flows on the relevant infrastructure.  In such
circumstances, it would be usual to expect the concession agreement to
contain a renegotiation clause which will apply if certain specified
events occur such as a law change, force majeure event, act of
prevention or other project specific events.

If a renegotiation
event occurs the project company should be entitled to negotiate the
compensation to redress the financial impact of that event.  These
negotiations should seek to restore the project company’s ability to
service its senior debt and to restore a notional initial investor to
their original base case equity return from the project either by
extending the length of the concession term, increasing the tolls or
charges that the project company can collect or some other mechanism. 
Such a renegotiation clause is the quid pro quo for the expectation by
the government sponsor to share in any super profits which may be
realised by the project company.

In a New Zealand context
however, such a provision in the concession agreement will require
careful consideration given the parameters set out in the Land
Transport Management Act which prohibit concession agreements from
containing any fetter on the government’s ability to undertake or
permit alternative sustainable transport options.

The Australian
Federal Government Department of Finance and Administration has
published a number of papers in relation to PPPs including one which
specifically addresses risk management.   It is a guideline for any
government entities contemplating PPPs as how best to manage the
identification and analysis of risks likely to arise in any project. 
This paper and the practices which it recommends are consistent with
the Australian/New Zealand risk management standards (AS/NZS4360: 2004)
and should be a useful guide for considering the risks which may arise
and the best method of managing those risks for projects in New Zealand.

Another
practical challenge for any public sector entity proposing to enter
into a PPP is the development of a public sector comparator or
benchmark against which the PPP proposals can be judged.  Because the
alternative public sector procurement mechanism for the project is
likely to be significantly different to the PPP structure, it is
important that the public sector comparator is adjusted to reflect the
transfer of risks to the private sector inherent in the PPP structure
and other benefits which the public sector may obtain under a PPP. 
Development of a public sector comparator which is a useful analytical
tool guiding the value for money evaluations, assessment and management
of risk and contractual negotiations is a challenging exercise and
should not be underestimated.  It is likely to demand a significant
amount of time and cost for the government sponsor.
 
The
development of a public sector comparator needs to be a two stage
process involving a raw PSC or base costing which includes all the
capital and operating costs (both direct and indirect associated with
the government constructing, owning, maintaining and delivering the
service or asset over the same period as the PPP proposal).  This raw
PSC then needs to be adjusted for transferable risks (the risks which
the government would bear under a traditional approach but is likely to
transfer to the private sector), retained risks (the risks which the
government proposes to bear itself under the PPP arrangement) and a
competitive adjustment (an adjustment which removes the net competitive
advantages that accrue to a government agency by virtue of its public
ownership (eg. tax exemptions)).

There has also been debate in
Australia as to the appropriate discount rate which should be applied
to the public sector comparator to calculate a net present value of
future cashflows .  The risk adjusted discount rates are an attempt to
incorporate in the PSC an assessment of the systemic or market risk of
the project as defined in various capital asset pricing models. 
Identifying the market risks which are transferred in a PPP model as
opposed to a public procurement is inherently difficult and involves an
element of “crystal ball gazing”.  The debate on this issue only serves
to underline the importance of developing a public sector comparator
which is realistic but which is not over engineered.  The public sector
comparator should only be one factor in conclusions as to whether or
not a PPP represents value for money, particularly for large or one-off
projects where the analytic comparison should be against a range of
benchmarks rather than simply one alternative public procurement model
which is then risk adjusted.
 
There is also the question of, if
a public service comparator is used, whether or not the underlying risk
assumptions are disclosed to the bidders so that they can incorporate
them into their own base case models.

Generally, the government
sponsor would be served by increased transparency of the underlying
assumptions in the public service comparator so that the private sector
bidders are able to bid on the same assumptions and therefore enable
the bids to be compared on a “apples for apples” basis.

If the
private sector bidders are unaware of the assumptions which are being
used by the government sponsor to construct the public sector
comparator and to analyse their bids, they will potentially either
under or over value the risks adjustments leading either to a higher
risk premium being incorporated in the bid price or, alternatively
under pricing risk which could lead to difficulties for the project
during its life.

Lessons for New Zealand
The
debate over whether PPPs are an appropriate structure for the
development of roading infrastructure in New Zealand has been underway
for some years now.  There is, unfortunately, a reasonable degree of
rhetoric in the debate, some of which is uninformed and misleading. 
Because of the nature of the projects (provision of ‘public’ assets or
services) the issues surrounding PPPs appear to be inherently political
which tends not to assist in the clarity of the debate.  On 7 February
2008 the issue of PPPs was put back on the public agenda in New Zealand
when Ministers Michael Cullen and Annette King announced that a
steering committee was to be established to investigate the possibility
of utilising a PPP to develop the Waterview Connection, a $2 billion
tunnel project which will complete the western ring route in Auckland. 
The steering group is made up of representatives from the Auckland
Chamber of Commerce, Business New Zealand, The New Zealand Council for
Infrastructure Development, Treasury and the Ministry of Transport. 
The steering group is expected to deliver a business case that assesses
whether procuring the Waterview Connection as a PPP is viable and could
deliver value for money.  It will also develop a benchmark public
sector comparator against which the PPP business case will be assessed.
 
It
is commendable that the terms of reference for the steering group
indicate a focus on value for money in the wider context as being the
criteria for deciding which option should be adopted for the
development of this project.  There is also recognition that the value
for money decision also includes achieving optimal risk sharing over
the life of the project and developing innovative solutions necessary
for the effective delivery of a complex project like this and not
simply choosing the cheapest procurement method.
 
However, the
Land Transport Management Act already provides a framework for any PPP
concession arrangement and a procedure for approval of any such
proposal.  Whilst the steering group should be able to work with
Transit to develop a workable public sector comparator, it is going to
be difficult for them to identify the most suitable form of PPP for
Waterview or to make any realistic recommendation as to which of the
two procurement methods should be adopted without actually creating a
scope for the project and calling for tenders.  Consulting with
potential bidders will not, in the author’s view, provide the steering
group with sufficient information or certainty in order to be able to
make a formal recommendation.  Whether or not a PPP is suitable for
Waterview is a decision which will ultimately be made by the Ministers
under the framework established by the Land Transport Management Act. 
That decision will only be able to be made against a fully developed
and fully costed tender which can then be compared, using the value for
money standards, against a fully developed public sector comparator.
 
Another
potential hurdle in the terms of reference of the steering group is
that it is stated that decisions relating to funding of the project are
to be made at a later time.  It is queried how it will be possible to
reach an informed decision about whether a PPP model could provide
value for money when there is no direction given as to how the project
might be funded under a government procurement model?
 
It is
clear that PPP is not a “magic bullet” solution to all infrastructure
development requirements.  It may be the case that in the New Zealand
land transport environment, a PPP simply does not stack up.  It is
entirely possible that the existing agencies who have extensive
experience in the area of constructing and managing land transport
infrastructure with access to government funding, potentially
supplemented by tolling in appropriate circumstances and/or the use of
the new tool of regional fuel taxes, are the best placed to develop
projects such as the Waterview Connection, the second harbour crossing
in Auckland, Transmission Gully in Wellington and other projects which
are on the government’s priority list.  PPPs have proven to be a useful
tool for infrastructure development overseas and, despite a few
failures, have largely been successful in achieving the objectives of
the best value for money development of large infrastructure projects
and delivery of public services.  PPPs have delivered projects on time
and on budget more often than not and they have provided a framework
for the accelerated development of infrastructure which in turn
provides a platform for economic development in the relevant
jurisdictions.  New Zealand should be open to the possibility of
utilising PPP for some of these major roading projects and should not
be afraid of investing the money and time required to adequately test
PPP proposals for appropriate projects.

References
1.
Public Private Partnerships – The Dawn of a New Error for Project
Financing,  Alan Millhouse, Building and Construction Law  Volume 18
October 2002 at 286-321.
2. Private Public Partnership Initiatives Around the World: Learning From The Experience.  Karisa Ribeiro and Andre Dantas.
3.
Review of Partnerships Victoria Provided Infrastructure - Report to the
Treasurer by Peter Fitzgerald, Growth Solutions Group, January 2004.
4.
Development of PPPs in Victoria by Glen McGuire and Arseni Malinovitch,
Australian Accounting Review, Volume 14 No. 2, 2004 at 27–33.
5. Synthesis of Public Private Projects for Roads, Bridges and Tunnels From Around the World – 1985-2004.  A E Comm Consult Inc.
6.
Public Private Partnerships in the Development of Transport
Infrastructure - Trends on both sides of the Atlantic.  Benjamin G
Perez and James W March – Conference Paper presented at First
International Conference on funding transportation infrastructure,
Institute of Public Economics at University of Alberta, Alberta,
Canada, August 2006.
7. PPP Projects – The Risk Debate, Steven
Carcano, Biggers & Paisley, Australian Construction Law Newsletter
No. 105, November/December 2005 at 28.
8. An Overview of Risk
Allocation in Recent PPP Infrastructure Projects in Australia by Andrew
Chew, David Storr and Geoff Wood, The International Construction Law
Review, 22 (3) July 2005 at 289-329.
9. www.nzcid.org.nz
10. www.partnershipsuk.org.uk
11. www.pppcouncil.ca
12. www.pppforum.gov.au
13. www.ip3.org